Recessions usually play out in a predictably grim rhythm.
Consumers pare back spending as they either lose their jobs, or worry about the prospect of unemployment. That hurts sales at businesses, which then cut back on payroll, and those workers then reduce their spending. And for 80 years, the typical political response to myriad typical recessions has been to dump a lot of money into the economy to break that cycle of misery.
The COVID-19-induced economic turmoil of the past year has been anything but a typical recession, with consumers sidelined more by public health worries than pocketbook concerns. But as the federal Liberals prepare a budget, they appear to be readying a standard-issue stimulus package. In its fall economic statement in November, the government earmarked $70-billion to $100-billion in stimulus spending over the next three years.
Economists are warning that Ottawa is in danger of not only targeting the wrong areas of the economy, but also of strengthening inflationary pressures.
Over the past year, the economy contracted not so much because consumers didn’t want to spend, but because their opportunities to do so were sharply limited by lockdowns and travel restrictions. As a result, household savings rates soared. Bolstered by massive income-support spending by the federal government, households stashed away unprecedented savings in 2020 – as much as $200-billion, TD Economics said in a research note issued Thursday.
How much of that excess will be spent is unclear. The Liberal government has pointed to those savings as “preloaded stimulus” that will complement its spending plans. The Bank of Canada is adopting a cautious position, saying last week it expects just $25-billion of excess savings to be spent over the next three years.
But private sector economists are much more bullish. “We think there will be a quick boost,” says Rebekah Young, director of fiscal and provincial economics at Bank of Nova Scotia, adding that the central bank’s forecasts are “quite conservative.”
In its research note, TD Economics said the $200-billion in excess savings in 2020 is equivalent to 9 per cent of Canada’s gross domestic product. TD is forecasting that consumers will spend just 10 per cent of that amount over the next two years, although that is still a faster pace than that forecast by the central bank. But TD said there could be a “turbocharged” recovery in which consumers spend 25 per cent of the excess within the next two years.
Ms. Young said she believes that consumers will be ready and willing to spend. The bigger question may be whether they are able to spend as much as they want because of production bottlenecks. Economists are projecting that the Canadian economy could close the gap with its potential output by late this year. That is a stark contrast with the 2008-09 financial crisis, when it took years for the output gap to close.
The massive U.S. stimulus measures launched earlier this month will only heighten pressures. The US$1.9-trillion package is undoubtedly good news for Canadian exporters. But surging demand south of the border will create additional capacity strains here.
Under those conditions, tens of billions of dollars in federal stimulus spending could simply push more money into an economy that already can’t produce enough, akin to pouring water into a cup that’s already full. “We shouldn’t be overstimulating the economy,” says Kevin Page, president and chief executive officer of the Institute of Fiscal Studies and Democracy.
Instead, economists say, Ottawa should focus on making a bigger cup, with any stimulus spending directed toward alleviating supply constraints by increasing productivity and boosting participation in the labour force.
Alexandre Laurin, director of research at the C.D. Howe Institute, said the federal government could boost investment tax credits for business as well as commit to not increasing the corporate tax rate. An extension of the two-year freeze in Employment Insurance premiums would also assist businesses in creating jobs, he said.
Cutting business taxes has not been at the forefront of the federal Liberal agenda, but other ideas floated by private sector economists may be a better fit with the government’s priorities, particularly the imperative laid out in the fall Throne Speech for an expanded role for Ottawa in child care.
The lack of child care during the pandemic is not only a worry for families, it’s a bottleneck for the economy, as women especially have been forced out of the labour market. Increasing the availability of affordable child care would help buoy labour force participation rates for parents, particularly women.
Ms. Young and Mr. Laurin both suggested that Ottawa could increase the child care tax credit as a quick first step, even if the government wants to pursue complex negotiations with the provinces about an expanded federal role in funding child-care spaces. Ms. Young said increasing the credit to $20,000, from the current $8,000, would assist families in paying child-care bills ahead of a broader plan to create new publicly funded capacity.
Even with the broad economy rebounding sharply, there are still concerns about persistent weakness in the labour market. Reforms to the EI system – something Ottawa has already signalled it will move on – would help smooth the path to the job market. Mr. Laurin said the government could consider creating a new benefit that would supplement the earnings of those returning to the work force as a way of reducing financial impediments to the unemployed.
But none of that can happen until the coronavirus is defeated. In that sense, vaccines and eventual herd immunity will be the most effective stimulus measure by far. “What’s key here is the roll out of the vaccine,” said Pedro Antunes, chief economist at the Conference Board of Canada.
Tax and Spend examines the intricacies and oddities of taxation and government spending.
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